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Strategic defaults have been steadily increasing in the residential housing market, as the stigma from having a foreclosure is lessened by the tidal wave of foreclosures across the country. These intentional defaults became such a problem that mortgage giant Fannie Mae now says that homeowners who choose to do a strategic default will be barred from getting another Fannie Mae mortgage for seven years.

A strategic default is when the homeowner can afford to keep making the mortgage payments, but chooses to default anyway because the house is now worth less than the mortgage balance.

In a recent press release, Fannie Mae warns: “Defaulting borrowers who walk away and had the capacity to pay or did not complete a workout alternative in good faith will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure.”

In addition, the press release said: “Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments.” (California bars deficiency judgments after foreclosure if the mortgage was used to purchase the house. All other states allow them.)

With Fannie Mae’s 95% market share for all new mortgages, this is a serious threat to homeowners who decide to go this route.

Background: Ten-plus years of incompetent and/or nonexistent regulatory oversight of mortgage brokers and lenders resulted in several trillion dollars worth of bad real estate mortgages being sold to Fannie Mae, Freddie Mac and other investors on Wall Street. When huge numbers of those bad mortgages started to default, our banking and economic system started to collapse, and massive government bailouts were initiated to prevent widespread bank failures. In spite of the fact that Fannie Mae had a history of multi-billion dollar accounting fraud, in addition to their criminal mismanagement, Congress declared Fannie (and Freddie) to be the country’s “mortgage experts” — after their collapse required a government takeover. Taxpayers have paid $146 Billion so far to cover losses at Fannie and Freddie, and the Congressional Budget Office has predicted that the final bill could be $389 Billion.

After that lengthy track record of astounding incompetence, Fannie Mae and Freddie Mac announced their new Home Valuation Code of Conduct (HVCC) in May of 2009. The HVCC was a set of real estate appraisal rules that would apply to every loan that Fannie and Freddie purchased.

The new rules were created to prevent a repeat of the mortgage disaster by supposedly eliminating undue influence on appraisers by interested parties to a transaction. So instead of fixing the incompetent and/or nonexistent regulatory oversight of mortgage brokers and lenders (no audits, no prosecution for loan fraud, etc.), we now have a new set of rules. No audits or real oversight, just more rules. They were supposed to transform the mortgage lending business, and they have — the new appraisal rules are a disaster.

Here’s how the new system works: lenders charge homeowners upfront for their appraisal, then they place an order with an appraisal management company, who then solicits bids from appraisers for each job. Most appraisals usually end up being assigned to the lowest bidder, not the most qualified appraiser. And the management companies keep most of the appraisal fees, forcing appraisers to work for starvation wages. (Appraisers are typically paid $160 to $170 for an appraisal, while the management companies charge homeowners about $400. This is why the management companies are fighting a new rule that would force them to disclose the fees they are getting to homeowners.)

What the public isn’t told is that many major lenders have ownership interests in the new appraisal management companies. So the new rules were created to end whatever influence that Realtors, mortgage brokers and homeowners might have had on appraisers, and we now have mortgage lenders that are able to exert tremendous pressure on appraisers — and pocket huge amounts of money without any disclosure.

Appraisals done under the new rules are frequently disasters. Due to the drastic pay cuts that management companies have forced on appraisers, many have left the business. And the ones who are left (the ones willing to work for 60% less money) usually have to cover larger territories than before, which means that they are often performing appraisals in unfamiliar areas. This can result in shoddy, inaccurate appraisals.

Since appraisals are usually going to the lowest bidder instead of the most qualified person, appraisals have been coming in so low that many real estate transactions are being killed. New home builders have been victimized by appraisers using lower foreclosure and short sale comps on older homes instead of comps on similar new homes. Once again, shoddy and inaccurate appraisals.

Many Realtors have seen their transactions blow up right before closing when appraisals come in at significantly lower values. When Realtors discover that higher (valid) comps were not included, they try to get the appraisers to use those comps, but their requests are typically ignored.
There are several reasons that appraisers will typically refuse to update an appraisal with different (higher) comps. First, they are working for 60% less pay, so fixing and re-issuing an appraisal means even more work for less money. Second, they are afraid to turn in appraisals with higher values because they know that lenders want to see lower values and they have to keep the lenders/management companies happy or they will be out of a job.

To make matters worse, the new rules also prevent homeowners from getting another appraisal right away if they are not happy with the first one. They have to wait at least 60 days before requesting another appraisal.

There you have it, another wonderful new government fix for a govenment-created problem. And this fix has the added benefit of helping to drive home prices even lower, which means more foreclosures. Aren’t we lucky to have “the best and the brightest” running things?

Many real estate investors have given up on buying investment property due to their inability to find financing. In some cases, this is due to tighter credit and income documentation rules (no more stated income loans). However, most investors have discovered that even well-qualified borrowers (great credit, cash reserves, proof of income, etc.) are unable to get mortgages to buy or refinance investment properties.

Most lenders have decided to stop writing loans for people who have more than four mortgages — even though Fannie Mae rules allow investors to have up to 10 mortgages. (See our post titled, Fannie Mae Does Investor Loans.) So Fannie would buy these loans from local lenders without recourse, but the lenders don’t care.

Resourceful investors have figured out how to overcome this problem by using private lenders instead of conventional banks and/or mortgage lenders. In most states, no license or registration is required for the lender or the borrower, as long as the private lending is done correctly.

This means no loans from strangers immediately after running ads to find a lender (there must be a pre-existing relationship between the lender and the borrower), and the private mortgage cannot be securitized (sold and resold in pieces over time, like shares of stock). So one private mortage on a property, between a lender and a borrower who knew each other before any lending took place, should be OK. This is not legal advice, so be sure to consult an attorney before doing this.

How do you find private lenders? The best way is by spreading the word. Get some business cards, put together a credibility kit (who you are, what you do, pictures of properties that you have rehabbed or flipped, etc.) and start spreading the word that you help people earn higher returns on their retirement money, fully secured by real estate. Tell your doctor, dentist, lawyer, accountant, family members, friends, neighbors, anyone you can think of who might have some money in a savings or retirement account.

What kind of returns should you offer? More than banks pay, but low enough that you can still make a profit. If you’re a rehabber, and you only need funds for 3-6 months to purchase and rehab houses that will be resold, then you might have to offer higher returns (10% to 15% APR) to make up for the quick repayment.

If you need funds long-term (5-10 years) to buy and hold rental property, then you’ll only be able to offer a return of 6% to 7% (double the rate for 5-year bank CDs). Make sure the loan payments are interest only to improve your cash flow and make the accounting easier. (Most private lenders prefer this anyway, as it means that all their money is earning interest.)

The rates you will have to pay for private money will depend on your track record, your relationship with the private lender, and your negotiating skills. As you gain experience, the rates you pay should be going down because you will have multiple lenders to pick from. Make them compete for your business by lowering their rates.

We hope this information will help you in your acquisition of investment property in Sacramento – and achieving financial independence. For more information on private money and private lenders, see our private lending website at A-1PrivateLending.com.

If you’re not an experienced, long-time real estate investor, here are some basic investing tips that can help you get started buying Sacramento investment property without making any fatal financial mistakes.

1. Don’t be paralyzed into complete inaction by the fear of making mistakes. This is known as “analysis paralysis” and it prevents most people from achieving financial independence because they never get started. No matter how many deals you have done, you are going to make mistakes because you’re human. But if you are careful, you should be able to limit your mistakes to ones that merely reduce your profits, rather than causing real financial losses.

2. Are you afraid to invest because you think property values might go down? Well, they might. In fact, there is a greater chance (right now) that prices will go down rather than up. Home prices across the country have already dropped 30% to 50% in some areas, and they MIGHT drop another 10% to 15% in some areas. However, some areas are already experiencing sustained recoveries with rising prices. So if you’re waiting until all the newspapers are saying, “Home prices are now up 10% year over year,” it will be too late. The only way to accurately call the exact bottom is by looking in the rear view mirror, which means you missed it.

3. There is a solution for the “falling prices, fear of buying” problem: Never pay retail! The bigger the discount, the safer it is to buy. Look for undervalued investment properties and if the numbers make sense, don’t be afraid to buy! Smart investors can usually find great deals in any market, but it’s easier to get huge discounts in a bad market.

4. Know your market and know what you’re doing. If you’re buying properties to keep as rentals, be sure to base everything on real numbers, not verbal or hypothetical ones. Don’t trust anyone else for the facts, verify everything yourself. Get your own inspections and bids, research the rental market for actual rents and vacancy rates, look up the crime rate, and verify the actual expenses. Ask for the Schedule E from the seller’s last two tax returns. If they won’t provide the Schedule E, assume that actual expenses are 35% of the rents (not including mortgage payments). Always buy rental property based on the actual cap rates, and always buy for less than the asking price. Remember that “pro-forma” numbers are always BS.

5. If you’re buying property to rehab and flip, know your price points (buying and selling) and the actual costs of rehabbing. On your first rehab, partner with an experienced rehabber and split the profits. That way, your chances of actually making a profit will be a lot greater. (Going it alone before you have some experience is a lot riskier. Most investor horror stories involve rehab projects.)

So do your homework, be sure to buy low (the lower the better), and don’t be afraid to buy if everything checks out. Buy right, sell right, make a profit, then repeat the process. That’s how you profit from investment property Sacramento.

Effective February 1, 2010 – FHA will waive their 90 day seasoning rule for a one-year trial period. This is great news for sellers and buyers of investment property in Sacramento! In the past, it was difficult to resell properties because the end buyer could not use FHA financing unless the seller held title for 90 days. This meant that the seller (wholesaler or rehabber) had to sit on the property for 90 days or try to find a buyer who did not need FHA financing, which ruled out about one-half of all potential buyers. There are still some restrictions, but here are the basics (be sure to read the new rules for yourself):

1. The seller must hold title to the property (no assignments or simultaneous closings).
2. The sale must be an arms-length transaction (no tricks).
3. Sellers are allowed to hold properties in trusts, S-Corps and LLCs as long as they are legit/legal.
4. There can be no pattern of previous flipping activity on the subject property within 12 months.
5. The property must have been marketed openly and fairly via MLS, auction, FSBO or developer marketing. Any contracts that refer to an “assignment of contract” may be RED FLAGGED.
6. If the sales price of the property is 20% or more over and above the seller’s acquisition cost, additional rules apply. For example, there must be documented rehab and/or repairs to justify the increase or the appraiser must provide an explanation for the increase in value since the prior title transfer. The lender must also order a property inspection and provide that inspection report to the purchaser before closing. (The borrower can be charged for this report.)

When the government’s Home Affordable Modification Program was announced back in March, the goal was to save four million homeowners from foreclosure by getting their mortgage payments permanently reduced. The Treasury Department recently reported that 728,000 trial modifications are underway, but only 31,382 homeowners have received permanent loan modifications.

The trial modification period lasts for three months, during which homeowners are required to make all payments on time and provide documents regarding proof of income and owner occupancy. Lenders report that almost half of the homeowners fail to provide required documents during the trial period, and about a quarter of them default again before the trial period is over. After reviewing the income documents, many homeowners are found to be ineligible for permanent modification due to insufficient income.

What does this mean for real estate investors? It means that the majority of foreclosures are only being postponed by the loan modification program (less than 1% of the four million foreclosures have been converted to permanent loan modifications), so there will be millions of additional foreclosed properties for sale in the next year or two. This should make it easier to find (and negotiate) huge discounts through short sales and REOs. Be sure to add some of these wholesale deals to your Sacramento investment property!

(Be sure to read the Fannie Mae Does Investor Loans post before reading this.) To see how many lenders were willing to make loans on investment property, we called every mortgage lender in a town of 50,000 people. Our informal survey included the four biggest banks in the US. We told them we were full-time real estate investors with ten financed properties (the limit set by Fannie Mae), excellent credit, low debt ratio, more reserves than Fannie required, and we wanted to refinance several loans on rental properties.

Here is what we found: Out of twenty lenders, all but two said the limit was four financed properties and some said they wouldn’t do rentals at all, even if we only had four mortgages. For the ones who said the limit was four, we asked if they knew that Fannie Mae had raised the limit to ten in February 2009, they all said they thought Fannie’s limit was four. So we asked them to email their underwriter to confirm the higher limit, and all of them called back to say something like “You were right, their limit is ten. But it doesn’t matter, our limit is still four. Sorry!”

We did find two lenders that could do the loans. Both wanted a 1% origination fee plus normal closing costs (appraisal, title insurance, etc.) Only one could do Fannie Mae loan products like ARMs (including interest only), but they wanted 3.5 points for those and 2 points to do a normal 30 year fixed, rates on both around 5.5%. Both lenders had 70% LTVs. The Fannie Mae lender could only do purchase mortgages and refinances with no cash outs, and the limit of ten financed properties applied. The other lender could only do 30 year fixed rate mortgages, had rates around 6.8% to 7.3%, but cash-out refinances were allowed and they had no limit on the number of financed properties.

Their underwriting guidelines: For the Fannie Mae loans, minimum FICO score 720, full documentation (two years tax returns, bank statements, W-2s, pay stubs), six months of reserves (PITI) for all financed properties, and two years of rental history (with positive cash flow) on the tax returns. For the other lender, minimum FICO score 660, full documentation, three months of reserves (PITI) for all financed properties, and positive cash flow on the rentals. (Negative cash flow on one or more rentals might be OK if the positive cash flow from the other rentals was far greater than the negative amount.)

How can you find lenders to finance your investment property in Sacramento? First, ask other landlords and investors if they know of any “investor-friendly” lenders in your area. You will usually have better luck if you spend your time looking for a portfolio lender, which is a lender that keeps their loans instead of selling them. Contact all of the smaller banks and credit unions to ask if they know of any local portfolio lenders.

If you find a bank that says they can do investor loans, be sure to ask if they’re brokering the loan (underwriting it for another bank). If they are, you can usually save money by eliminating the middleman and dealing directly with the real portfolio lender. And that’s how you find lenders for your Sacramento investment property!

Ever since the bank/mortgage implosion last year, it has become very difficult for investors to get financing. At first, Fannie Mae set a limit of four mortgages, which meant that investors who had a mortgage on their personal residence plus three more mortgages on investment properties could not get any more loans because Fannie Mae would not buy them from the originating lender. And 99% of lenders would not even think about underwriting new loans if they couldn’t sell them.

Congress eventually figured out that this policy was making the real estate market worse by eliminating investors who represented 20% to 25% of the home buyers. So now the Fannie Mae limit is ten mortgages total, including your personal residence. If you have four mortgages or less, they will allow cash-out refinances on investment properties. More than four and all you can do is a new (purchase money) loan or a refinance with limited cash-out, where you are only permitted to add the loan fees/closing costs to the loan balance. On your personal residence, Fannie will allow refinances (including cash-out) even if you have ten or more mortgaged properties.

The new rules also require full documentation (tax returns, proof of income, W-2s, pay stubs) and good credit. No more stated income loans! If you think you qualify, start calling all of the mortgage lenders in your area. Why? Because most are probably going to say that the limit is four mortgages, even though it is really ten at Fannie Mae. When this happens, ask if they realize that Fannie increased the limit from four to ten and see what they say. (Suggest that they email their underwriter to verify the higher limit.) In most cases when they say the limit is four, it’s really because the bank is too lazy to do loans for clients with ten mortgages because the underwriting process involves a little more work for them. So just keep calling lenders and you will eventually find one who isn’t afraid of a little work. Then you can buy more Sacramento investment property!

Thanks to lower home prices — caused by a flood of foreclosures — and the $8,000 tax credit, home sales (and prices) are up slightly in most local real estate markets. However, the increase in prices is only over the last six months. Year-over-year prices are still down 11% for most major markets, including Sacramento, but the lower prices have caused home sales to increase dramatically at the lower end. Many first-time home buyers are now able to buy, and bargain hunters are picking up more investment property in Sacramento.

Many have been wondering if this is “the bottom” of the real estate crash, to be followed by prices steadily rising like the good old days. While no one has a crystal ball, there are several important facts to consider. First, it’s unreasonable to expect a real estate recovery with millions of lost jobs, bank failures and foreclosures accelerating, and a huge “shadow inventory” of repossessed homes that lenders are withholding from the market (approx. 2.5 million homes). In fact, there are so many foreclosures that Fannie Mae has practically given up on selling them and is now renting them out (see the Fannie Mae Landlord post). So we probably have another two years to go before things get better long term.

Home prices might drop some more (like they do every winter), and they might go up a little (like they do every spring). Another huge government tax credit for home buyers could boost prices again, while another flood of foreclosures could depress prices. Get the picture? (It’s cloudy.)

So, is this a good time to buy investment property in Sacramento? It is if the numbers make sense and you’re buying at wholesale prices. Since no one can know the exact bottom until the market goes up (and stays up), smart buy-and-hold investors buy when the ROI/cap rate numbers look good, and smart rehabbers buy when prices are cheap enough to make a profit. Just don’t get caught up in bidding wars with others who buy on emotions, not on the numbers. Remember, your profit is created when you buy. Pay too much, and there will be little or no profit when you sell, or a poor ROI/cap rate if it’s a rental.